May 28, 2013
Executives
Katie Turner Steven L. Spinner - Chief Executive Officer, President and Director Mark E.
Shamber - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Treasurer
Analysts
Andrew P. Wolf - BB&T Capital Markets, Research Division Sean P.
Naughton - Piper Jaffray Companies, Research Division Meredith Adler - Barclays Capital, Research Division Stephen W. Grambling - Goldman Sachs Group Inc., Research Division Kelly A.
Bania - BofA Merrill Lynch, Research Division Ajay Jain - Cantor Fitzgerald & Co., Research Division
Operator
Greetings, and welcome to the United Natural Foods Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Katie Turner of ICR. Thank you, Ms.
Turner, you may now begin.
Katie Turner
Thank you, and good afternoon, everyone. By now, you should all have access to the third quarter fiscal 2013 earnings press release issued this afternoon at approximately 4:05 p.m.
Eastern Time. If anyone still needs to review the release, please reference the Investors section of the website at www.unfi.com.
As a reminder, the webcast of the earnings call is also available on the company's website. On the call today are Steve Spinner, President and Chief Executive Officer; and Mark Shamber, Chief Financial Officer.
Before we begin, we'd like to remind everyone, comments made by management during today's call may contain forward-looking statements. These forward-looking statements discuss plans, expectations, estimates and projections that might involve significant risks and uncertainties.
Actual results may differ materially from the results discussed in these forward-looking statements. Additionally, in today's earnings press release and during the call, the company will provide both GAAP and non-GAAP financial measures, including operating expenses, operating income, net income and earnings per diluted share.
Presentation of these non-GAAP financial measures is not limited to the -- is not intended to be considered in isolation or in substitute for any measure prepared in accordance with GAAP. For a complete reconciliation of GAAP and non-GAAP financial measures, please refer to the company's earnings release issued earlier today and available on the company's website under investors.
And with that, I'd like to now turn the call over to Steve Spinner.
Steven L. Spinner
Thanks, Katie. Good afternoon, everyone, and thank you for joining us today to discuss UNFI's financial results for the third quarter and first 9 months of fiscal 2013.
Our consistent solid financial performance demonstrates that demand for UNFI's products and services continues to grow and highlights our focus on improving efficiency and driving further operational excellence across our business. In the first 9 months of this fiscal year, our net sales grew almost 14%.
And sales during the third quarter grew almost 13% when comparing to the same period last year, again, reflecting the dynamic and expanding organic natural and specialty industry. Our operating profit, adjusted for our Auburn Labor Action, grew almost 14% in the quarter versus the same period last year, and our operating margin expanded by 4 basis points.
For the year, our net income has increased 14.5% versus prior year. Two important notes: We have now lapped the onboarding of Safeway and inflation was again very modest at approximately 2%.
And interestingly, the year-over-year inflation spread is now at its greatest gap as inflation in Q3 2012 was 4%, a 200-basis-point difference. This further accentuates the strength in our sales growth.
Our consistent top line growth reflects consumer demand being driven by more and more people maintaining healthier lifestyles with a growing interest in natural, organic and specialty products, food safety and environmental awareness. According to industry data published by SPINS, last year, natural and organic products continue to outpace overall store growth across all channels.
We expect this trend to continue for the foreseeable future. Another interesting data point supporting the growth of our industry is consumers' growing demand for transparency in food labeling.
People are becoming more and more interested in knowing if the food they buy is made with genetically modified seed, also known as GMOs. And we believe that this interest will result in federal guidelines requiring the labeling of GMOs.
UNFI is a proud supporter of the non-GMO movement and currently produces many products through our Blue Marble division, which are certified not to contain GMOs. To ensure that we are positioned to capitalize on the positive industry trends and corresponding growth opportunities for UNFI, we are working on a number of new construction projects to enhance our national distribution infrastructure.
Just 2 weeks ago, we moved into a new facility for our Albert's Organic division, which is one of the country's largest distributors of organic produce and perishables. Sales growth for this division have been consistently strong in the past couple of years, and our new facility will help us better service our customers.
One of our fastest growing categories continues to be organic fresh produce and natural antibiotic free proteins, which are now distributed by our Albert's division. UNFI's Albert's division has been delivering high double digit sales and operating income growth for the last several years.
We are now on track to open a new distribution center in Denver in the early summer of this year. The building is now open, and we are receiving product for our core distribution and our Albert's business, which is now integrated into this 540,000 square foot building.
The distribution center replaces 3 existing facilities in the area, and we believe will significantly enhance our service level and product offering. Additionally, we are aiming for Gold LEED certification in this facility.
We also plan to build new facilities within the next 14 to 24 months in Wisconsin, Hudson Valley, New York and Northern California. These new facilities will create capacity for growth and keep us very close to the retailers, which allow us to meet the high level of service and quality that is critical for our business, while continuing to drive out cost.
In the third quarter, we incurred approximately $1 million in costs associated with buildings not yet occupied. While these costs will continue for the next several years as we continue to build capacity, we believe these are necessary steps to invest in our future growth opportunities.
The construction will also present us with several interesting financing alternatives, which we will discuss in subsequent quarters. Our goal is to continue producing free cash, while maximizing the strength of our balance sheet by using currently owned and under construction real estate.
Now focusing on our customer mix for a few moments. During the third quarter and compared to the prior third quarter, supernaturals grew 36 -- to 36.6% from 35.7% of our net sales; supermarkets grew to 24.3% from 24.2%; and independents declined to 33.7% from 35.1%.
Interestingly, all 3 channels are growing rapidly, with supernaturals leading growth during the quarter with 15.5% sales growth over the third quarter and the prior year. Our independents are also growing quite nicely, and UNFI continues to be deeply committed to this very important customer base.
As they anticipated, our gross margin was impacted by the continued shift in customer mix to the conventional supermarket and supernatural chains. On a sequential basis, our gross margin in the third quarter of fiscal 2013 were 16.8%, which represents an increase of 7 basis points compared to the second quarter of this fiscal year.
On a year-over-year basis, gross margin declined 83 basis points from 17.6% in the third quarter last year. While there will continue to be pressure causing some quarterly volatility in our gross margin, we continue to be optimistic that there will be more stability as our customer mix shifts stabilizes and our strategies take hold.
Another factor that continues to impact our gross margin is higher than normal supplier out-of-stocks, which we had spoken about on previous calls. We're pleased that in the third quarter of fiscal 2013, our out-of-stock rate improved sequentially versus the second quarter.
However, it was 67 basis points and $17 million worse than in the prior-year period. During periods of high supplier out-of-stocks, UNFI loses the gross margin on these lost sales and reduce promotional activity.
Additionally, in many cases, we elect to move freight around the country at our cost to ensure higher levels of service. Now we continue to believe that this is a short-term issue, and we expect that manufacturers are making the appropriate adjustments to gear up for continued growing demand.
UNFI will carry additional inventory to ensure a high level of service to our customers, especially as we approach the holiday season. We continue to make progress on our initiatives to drive to operational excellence, with a focus on increasing leverage of UNFI's cost structure across higher sales volume and enhancing productivity.
In the third quarter, our operating expenses as a percentage of net sales improved to 13.4%, representing a decrease of 76 basis points compared to the prior-year period, despite incurring $1.5 million related to the labor action at our Auburn Washington facility. Adjusting for Auburn costs, our operating margin in the third quarter of fiscal 2013 improved 4 basis points despite the headwinds associated with supplier fill rates.
This improvement is important for us as we continue to confirm that UNFI shifting customer base can be supported through a very efficient cost model. On the M&A front, we continue to look for attractive acquisitions.
The expanding product offerings and geography are important to our growth strategy looking out over the next 5 years. Additionally, our previously completed acquisitions are moving forward as we planned.
From our Pacific Organics Produce sourcing business to our Canadian specialty distributors B.K. Sethi and Disley, UNFI is delivering strong results within these companies.
Operationally UNFI is excelling as demonstrated in our service levels, productivity. Our warehouse metrics, which measure our cost per case and our transportation metrics, which measure our delivery efficiency are all at record highs.
This is a direct result of our national operations team and their seasoned organizations. Their results are driving factor in our ability to deliver record operating expenses, which are necessary as we change our customer base.
We are also implementing several exciting technologies to improve safety and cold chain management. First, we are now rolling out tractor cameras to enable higher levels of fleet safety; and second, we have successfully tested the use of onboard, online and wireless sensing devices for our temperature-controlled trailers.
This system provides additional cold chain integrity and is critically important to delivering the highest standards for food safety. Also, we're on track to convert 3 DCs per year onto our new management warehouse system with Auburn, Washington going live this summer.
And we have also successfully begun implementation of our inventory optimization platform, with 60% of the West region suppliers converted. Our goal is to increase service level, while lowering overall inventory cost with enhanced transparency with our suppliers.
Turning to CapEx. Our capital expenditures during the quarter were less than 1% of net sales and were driven primarily by construction at our new Denver facility.
We expect CapEx will continue to ramp up as a percentage of sales as we build new capacity to support our growth, including the new projects I mentioned earlier in my remarks. Guidance for 2014 CapEx will be provided during our September conference call.
On the balance sheet, all of our metrics for payables, receivables and inventory remains strong, which resulted in continued leverage of less than 1x EBITDA. We have considerable flexibility to invest where necessary to continue to advance our growth and sustainability strategies.
Net income increased 14.5% during the first 9 months of fiscal '13 compared to the same period last year. Before I conclude my remarks, I want to highlight that UNFI was added to the Fortune 500 in their most recently published list.
This ranking is a testament to the strength of our industry and equally important to the hard work, passion, innovation and success of the UNFI team. We are excited about the opportunities ahead and look forward to continued growth and success.
And now I'll turn the call over to Mark Shamber to discuss our financials for the period. Mark?
Mark E. Shamber
Thanks, Steve, and good afternoon, everyone. Net sales for the third quarter of fiscal 2013 were $1.57 billion, which represents growth of 12.8% or approximately $178 million over the prior year third quarter's net sales of $1.39 billion.
Excluding the $12.5 million in sales from the 3 acquisitions that closed in the first quarter, sales increased by 11.9%. Inflation continued to moderate both sequentially and on a year-over-year basis for the quarter coming in at 1.76%, a 22 basis point decline from Q2, and a more than 250 basis point decline from last year's third quarter inflation of 4.43%.
Year-to-date net sales are $4.42 billion, yielding sales growth of $530 million or 13.6% over the comparable period in the fiscal 2012. Excluding the acquisitions, our year-to-date growth is 12.6%.
For the third quarter of fiscal 2013, the company reported net income of $31.6 million or $0.64 per diluted share, an increase of approximately 8.9% or $2.6 million over the prior year. Net income for the third quarter of fiscal 2012 was $29 million or $0.59 per diluted share.
Earnings per diluted share increased by 8.5% as EPS growth was impacted by the higher average share count in fiscal 2013. Looking at our sales by channel, as Steve mentioned Supernaturals increased by 15.5% in the third quarter.
Sales growth in the Supermarket channel was 13.6%, while the Independent sales accelerated to 8.3% from the 7.9% achieved in the second quarter. Finally, foodservice grew by 23.7% in the third quarter and foodservice continues to represent 3% of total sales.
As covered in the press release, gross margin for the quarter were 16.8%, an 83-basis-point decline over the prior year's third quarter gross margin of 17.6% and a 7-basis-point improvement sequentially. The primary drivers of our lower year-over-year gross margin continued to be the same factors that we have highlighted in the last couple of quarters, a couple of which were covered in the press release.
The ongoing shift in our growth mix towards both the supernatural and conventional supermarket channels will continue to pressure our gross margin as these customers on average have a lower gross margin. Additional factors are increased sales of customer's private label brands, higher inbound freight costs and fewer inflation related forward buying opportunities due to fewer price increases being generated by our suppliers.
Year-to-date, gross margin of 16.7% compared to 17.6% in the prior year, a decline of 84 basis points, again driven by the same factors along with the additional freight expense in the first half of the year associated with higher manufacturer out-of-stocks. Our operating expenses for the quarter were 13.4% of net sales compared to 14.1% for the same period last year.
This represents a 76-basis-point improvement over the prior year as operating expenses as a percentage of our net sales continue to benefit from the mix shift in our business, positive trends in our self-insurance areas along with strong execution by the general managers in our broadline distribution centers. Costs associated with the strike at our Auburn, Washington distribution center negatively impacted expenses by $1.5 million in the quarter or approximately 10 basis points.
These expenses came in higher than our projection at the end of the second quarter, but this quarter represents the end of these costs as the strike was settled in February. Similar to the first and second quarters, we incurred approximately $1 million in noncash straight-line rent expense and certain cash move related costs associated with our new Denver, Colorado area distribution facility.
Year-to-date, these nonrecurring expenses are $2.6 million and are in line with the full year guidance provided during our September 11, 2012 earnings call discussion. Excluding the portion of our Canadian business, which involves the use of third party for deliveries in certain regions, diesel fuel had a positive impact of 8 basis points in operating expenses in comparison to the third quarter of fiscal 2012, as fuel represented 71 basis points of distribution net sales in the quarter.
Fuel in the third quarter decreased by 1 basis point versus second quarter as our fuel expense increased 7.2% sequentially due strictly to the higher sales volume. Our diesel fuel prices in the third fiscal quarter declined by approximately 0.4% from the prior year's third quarter, while the Department of Energy's national average was down approximately 1% over the prior year.
Share-based compensation expense totaled $3.1 million in the quarter compared to $2.5 million in the prior-year second quarter. Share-based compensation expense represented 20 basis points as a percentage of net sales in the quarter, a 2 basis point increase over the prior year.
Operating income for the second quarter was 3.4%, a 6-basis-point decline over the prior year's operating income of 3.5%. Adjusting for the $1.5 million and 10 basis points associated with the Auburn strike, operating income was 3.5%, a 4-basis-point improvement over fiscal 2012's third quarter.
Our effective tax rate for the third quarter of fiscal 2013 was 39.5%. And as we look to the fourth quarter, we would expect the tax rate for the quarter to be in the range of 38.5% to 39.5% dependent upon our state taxes apportionment.
Inventory was $723 million at quarter's end as days inventory on hand averaged 48 days for the third quarter, an improvement of about half a day over the prior year's third quarter when we were at 49 days. The lower average days on hand resulted primarily from the acceleration in sales growth in the quarter despite maintaining higher inventory levels.
Our supplier bases continued to have out-of stock levels above historical trends, and we have elected to build inventory levels to compensate for these issues to the extent possible. Our service levels improved throughout much of the quarter, although certain categories such as CHIA, continue to have significant out-of-stocks.
Our DSO for the third quarter improved by approximately 1 day to 21 days, both sequentially and on a year-over-year basis. Capital expenditures were $14.7 million for the quarter and our $34.8 million or 79 basis points of net sales for the year-to-date, which is favorable to our full year guidance.
With the completion of 2 facilities in the fourth quarter and the groundbreaking for our new facility in Sturtevant, Wisconsin, which is near Racine, occurring earlier this month. Our fourth quarter capital expenditures will be more heavily -- our fourth quarter capital expenditures will be more heavily slanted.
In addition, our Auburn, Washington facility is scheduled to go live on our new WMS late in the fourth quarter. Outstanding commitments under our credit facility were $209 million at quarter end, with available liquidity of approximately $290 million, including cash and cash equivalents.
Our leverage decreased modestly while remaining at 0.8x levered on a trailing 12-month basis due to continued investment in inventory to try and compensate for continued high levels of out-of-stock across our supplier base. As discussed in this afternoon's press release, we are raising our net sales guidance for fiscal year 2013 to a range of $6.03 billion to $6.06 billion, which represents an increase of 15.2% to 15.7% over fiscal 2012's net sales.
Our previous sales guidance was a range of $5.88 billion to $5.98 billion. I'd also like to take this opportunity to remind you that fiscal 2013 is a 53-week fiscal year for UNFI.
The additional week occurs in our fourth fiscal quarter and is expected to contribute approximately 2.2% to 2.3% to our overall fiscal 2013 net sales growth. We have also updated our GAAP diluted earnings per share guidance for fiscal 2013 to a range from $2.12 to $2.14 as noted in the press release.
Our previous GAAP earnings guidance was $2.12 to $2.18 per diluted share. As a reminder, included in our fiscal 2013 earnings guidance, there's approximately $5 million to $5.5 million of nonrecurring expenses associated with our new Aurora facility and a new facility for our Albert's Organics division, of which $3.5 million to $4 million are duplicate, primarily noncash rent payments, with the remaining balance comprised of relocation costs to consolidate the existing facilities.
Excluding the special items referenced in this afternoon's press release, we expect diluted per share for fiscal 2013 in the range of $2.15 to $2.17 per share, which is an update of our previous fiscal 2013 guidance excluding those items, which had a range of $2.15 to $2.21 per diluted share and was included in our second quarter earnings release on February 26, 2013. At this point I'll turn the call back over to the operator for the question-and-answer session.
Shay?
Operator
[Operator Instructions] Our first question comes from Andrew Wolf from BB&T Capital Markets.
Andrew P. Wolf - BB&T Capital Markets, Research Division
A couple of questions. First, on the independent sector, doing a little better.
Do you think that's sort of market-wide or is that more some of the initiatives you spoke of adding territory managers and trying to get, I guess, more touch points with the customers and some of the technology and other things you are trying to bring to the table?
Steven L. Spinner
It's kind of hard to pinpoint exactly where it's coming from, but certainly those things you mentioned have helped us quite a bit in terms of getting more feet into the retailers' locations across the country, adding the iUNFI technology, adding some specialists into the market to concentrate on very specific product groups. Certainly the strength of our Albert's division as it relates to antibiotic-free, all-natural protein and specialty cheese.
So I think all those things have really contributed to the growth in the independent channel, as well as just the general demand for the product across all the channels.
Andrew P. Wolf - BB&T Capital Markets, Research Division
Okay. I guess another way or a follow-on to that is -- I mean, are you actually seeing new customer conversions or is it mainly a penetration, either category management or bringing like you mentioned new products, new categories?
Steven L. Spinner
Yes, I mean, we sell a large percentage of the independents across North America today. And so I think where we're having a lot more success is through further penetration of SKUs that we either hadn't had in the past and now have through additional promotional activity.
And just general health of the industry. I would say those are the 3 things that are driving the growth within that channel.
The other thing I would mention is that, within that channel are what we call our multiunit independents, which tend to be extremely fast-growing -- actually, the fastest growing within that segment. Those are typically independent retailers or retailers that have somewhere north of 10 locations.
It seems as though the new openings have ramped up much faster than they have in the last 3 years.
Andrew P. Wolf - BB&T Capital Markets, Research Division
Okay. And just wanted to ask about guidance, just putting some numbers in the model, looks like Q4 falls out to about 59 to 61, and operating margin's kind of flattish year-over-year.
And I guess I'm trying to tie that to, is that because you increased the noncash earnings impact at Aurora and Albert's Organics or is there something else that accounts for that?
Mark E. Shamber
Yes. I mean, Andy, as we talked about going through the year, I mean we're at about $2.6 million through the first 9 months of the year.
And this is the quarter where we're actually going to move those 2 facilities. I mean, as Steve mentioned, we've actually already done it on the Albert's facility and will be going through the process very shortly on the Denver facility.
So those are -- we lose the noncash piece of the rent in the fourth quarter, but then we actually have the physical moves cost, which if you were to go back and look, in some cases, have been as much as $2 million. And so you factor that in on the GAAP side, and really that's what's -- any improvements that we're getting on the rest of the business being offset by that being in the guidance for the fourth quarter.
Andrew P. Wolf - BB&T Capital Markets, Research Division
So it's about $2 million of move costs?
Mark E. Shamber
Yes. I mean, again, we're at $2.6 million and the guidance for the year was $5 million to $5.5 million.
So it could be anywhere from $2.4 million to $2.9 million in the fourth quarter.
Andrew P. Wolf - BB&T Capital Markets, Research Division
So I guess another way to ask, sales guidance went up, and yet I think versus most folks' models, it looks like margin is not -- operating margin's, like I said at least in my modeling, it looks a little around flattish. So -- and the guidance here doesn't change.
So is there another aspect? Is there a sales mix issue?
Is there something or are you guys just sort of being conservative based on lack of inflation or something you see out there?
Mark E. Shamber
Yes. I mean, I think it's a combination of those.
I mean, one, we continue to see the supernaturals are in line with historical growth, but the supermarkets growth has been much higher than the independents these last 2 or 3 quarters, which is driving down the gross margin and driving down the overall margins a little bit. Having covered this for a number of years, we are generally conservative in the guidance from that perspective.
So I think that the combination of the two, plus the move costs, honestly, they tend to come in a little bit higher than we envision sometimes, so we've left ourselves a little bit of room, if that is in fact the case. I mean, they don't always go off flawlessly even though the operations team does everything they can to make sure that happens.
Operator
Our next question comes from Sean Naughton from Piper Jaffray.
Sean P. Naughton - Piper Jaffray Companies, Research Division
Just on the shrink, you'd called it out as a little bit of drag last quarter, and I don't think I caught it that you called it out this quarter. But it does sound like you may be using some technology to track some temperature control in the trailers.
And maybe just give us an idea, is there really a big opportunity here on shrink and did that actually improve in the quarter?
Steven L. Spinner
Yes. Sean, I don't remember calling out shrink in the last call.
I'm pretty sure we did not. Our shrink rates are actually pretty good and have been pretty good.
Every once in a while, we get a hit, but I don't remember that there was anything called out in the last couple of quarters related to shrink. I mean, we've been talking about supplier service issues, but that's more out of stocks and not inventory loss that related from out of code, et cetera.
Mark E. Shamber
Yes. I mean, last year and the first half of the year, we had 2 successive quarters where we had that in fiscal '12.
But in fiscal '13, the run rates on the shrink side have been more consistent with historical trends. So there wasn't -- I mean, if we did perhaps give that impression, it was not intentional in the second quarter.
Steven L. Spinner
Yes. And also when we talked during that very brief period of time, it was basically we geared up our inventory for the holiday season.
And that's what caused some of the very brief shrink issues that we had.
Sean P. Naughton - Piper Jaffray Companies, Research Division
Okay, got it. And then private label, you did also call this one out again.
That's been increasing for the first few quarters of this year. Is there any sign of this particular dynamic moderating for you right now?
Or is this something, this is after we get through maybe the next quarter or 2 here, we should be potentially on a more normalized run rate, if you will, for that particular portion of the margin expectation moving forward?
Mark E. Shamber
Yes. I mean, this is an old story, unfortunately, for us.
I mean, basically, what we see is we see a big migration to private label. There's some pushback and then we see the private label fall off.
And then over time, it starts to come back again. So I think right now, we're in a situation where it is ramping up.
And so I think it will be a little bit of a drag for maybe the next couple of quarters, but it's not material. It's just a little bit of a headwind.
And I think that over time, consumers will ultimately push back and demand more national branded product, and it will fall off again. But right now, we still are in a little bit of an upswing.
And for clarity, private label is a net-net price structure, whereas nationally branded products are not. So all in all, nationally branded products tend to be more profitable for us to carry than private label.
Sean P. Naughton - Piper Jaffray Companies, Research Division
Got it. And then just a quick follow-up, and you guys have given this a number of times, but where do we stand on the warehouse management over the next 18 months?
How many do we expect to have in? How many do we have in right now?
And kind of what are some of the performance that you're seeing out of that implementation and rollout?
Steven L. Spinner
Yes. We have our third one going into Auburn, Washington this summer.
And then we'll be doing 3 a year, which I think is a schedule we can keep. And we see nice performance increases.
The biggest single change that happens when we put in our UNFI warehouse management system is we virtually eliminate selection errors. So from a selection perspective, we're almost 100% accurate.
But we have to take our time. We have to put it in right.
We've had a huge success in the second implementation in Ridgefield, Washington. So we feel like we're pretty good at it.
We've got a team dedicated to it. And so we'll knock off 3 a year following this summer's Auburn, Washington.
Operator
Our next question comes from Meredith Adler from Barclays.
Meredith Adler - Barclays Capital, Research Division
Talking just a little bit about both private label and the customer, I mean the vendor out of stocks, does more private label help you at all in that area? And then, I mean, I think you had -- I had a conversation with you about this that there's sort of a lag and then the manufacturers add some more capacity when they can.
But should we be worrying about the holiday, which is when you really had a big problem last year?
Steven L. Spinner
Yes. I mean, in part and the answer to the first part of your question, Meredith, I think historically, the out-of-stocks on private label tend to be higher than the out of stocks on the national brands just because they require a dedicated run to produce them.
So historically, I think that's the way we've seen it. I would say that right now, we have a fair degree of confidence that based upon what we're seeing in the suppliers that capacity is being added either through planned expansions or through the addition of new co-packers.
And we see it sequentially getting better, as I mentioned in the prepared remarks. And every manufacturer is in the same boat we are for the holidays, and that is that the retailer relies heavily upon that time period.
So we feel pretty good that we're going to be okay through the holiday season.
Meredith Adler - Barclays Capital, Research Division
Okay, great. And then just talking a little bit, you do have a lot of capital investment activity planned for the next 2 years.
I think you had promised that you'd be free cash flow positive. So I think maybe you could talk a little bit more about how you plan to fund those DCs or how you would do it to come up with the most money?
And then I have one sort of related question.
Steven L. Spinner
Yes. I mean, I made a little bit of reference to that in my prepared comments, and we have some very specific thoughts on financing the new buildings.
And as you know, we've got a very healthy balance sheet today. And so we're in the process of taking a look at bundling real estate both in terms of buildings that we already own and buildings that are currently under construction or soon-to-be construction, and using those buildings to create some very attractive financing alternatives for us.
Mark, do you want -- do you have any other comments you want to make on that?
Mark E. Shamber
Yes. I mean, I think the one thing I would note, Meredith, is that the timing of when this plays out may be a little inconsistent in the sense that we'll likely build the facilities on our own balance sheet, and then once they're complete, look at some sort of financing scenarios in that sense.
It just leads to a lower cap rate than what we will be charged if we were to sort of enter into financing transaction upfront. Plus, it allows us to manage the construction of the buildings in the manner and form which is most desirable from our standpoint.
So we'll be in a better position, particularly as it relates to timing, once we give our guidance at the end of our fourth quarter in mid-September. So -- but what you would likely see is as we build the buildings, the CapEx would flow through, but they, in the fourth quarter, once the buildings were complete, we might enter into sale-leaseback or some other similar type transaction.
Meredith Adler - Barclays Capital, Research Division
Okay, that makes sense. And then just my final question would be, will you be giving us some guidance on sort of the costs related to opening those facilities, the operating costs related to opening the facilities and cost to ship product or whatever you have to do similar to what you're doing in Denver?
And I know we called that out as being unusual, but is it fair to assume that we're going to have costs like that for the -- at least the next 2 years?
Steven L. Spinner
Yes. And that's part of the reason, Meredith, where we've put it into the guidance and we've not spoken about the operating expenses or operating income x those costs.
We've highlighted it so that folks know what they are and are able to trend it, but we will likely have some of those costs over the next couple of years. As it relates to giving you the information, we'll certainly do that when we give the guidance.
The further out we are on a construction project, the more likely that the dates could shift slightly. So we'll give a range as we've historically done, but depending on the weather, we could shift as much as a quarter in the construction schedule.
Mark E. Shamber
We spent a tremendous amount of time thinking about financing, thinking about the generation of free cash. And so we're very focused on that.
I mean, at the end of the day, fortunately it's a very rich problem to have that the business -- I mean, we've essentially added $3 billion in sales over the last 4 years. And so you have to build the capacity to meet the demand.
And we certainly believe that the fastest growth is in front of us, not behind us. So we've got to plan out capacity while not giving up on our strategy to build free cash and operating margin expansion every year.
And I think we can do that.
Operator
Our next question comes from Stephen Grambling from Goldman Sachs.
Stephen W. Grambling - Goldman Sachs Group Inc., Research Division
Just a quick clarification on the SG&A. Were some of the costs from the buildings not yet occupied also taken in the third quarter?
Mark E. Shamber
Yes. So that $1 million that we referenced, I think in my comments, I'm not sure, I think Steve actually mentioned it as well, but there was approximately $1 million worth of expenses in the results in the third quarter.
Stephen W. Grambling - Goldman Sachs Group Inc., Research Division
Okay, that's what I thought. So then when I look at SG&A just on a year-over-year basis, and maybe this isn't the best way to look at it, but it looks like it was the lowest it's been in years.
Can you talk about how we should think about these underlying rates and x some of these onetime costs going forward, and maybe how sustainable this rate is?
Mark E. Shamber
I think that it continues to go back to the mix shift in trying to answer that question, Steve. I mean, I can tell you that last year at this time we were asked whether or not we could get the expenses lower than what we've had because last year's third quarter was a significant uptick in that sense.
So I think what happens, I mean our third quarter is always our highest sales volume quarter. And so we tend to get the greatest leverage starting at that point.
We take a little bit step back in the fourth quarter because the volume declines sequentially a little bit excluding the extra week. And then we maintain that until we sort of get to the next year's third quarter with modest improvements as we go.
So I think that if I could tell you definitively where the sales by channel was going to come out, I'd probably be in a much better position to give you the exact mix because if we do more independent sales, we'll see higher expenses, but the profitability is higher on the independent's and total on average. So we'd be more profitable even though the SG&A side would go up.
So I think to answer it succinctly, it's a scenario where we'll continue to take the expenses out. We'll continue to get leverage.
The rate that we have for this quarter is sustainable, but you'll probably see a little bit of a step back in the fourth quarter and then maintain that until we get to next year's third quarter.
Operator
Our next question comes from Kelly Bania from Bank of America.
Kelly A. Bania - BofA Merrill Lynch, Research Division
Just quickly on gross margin. It's been incredibly stable over the past 2 or 3 quarters, and just wondering, I think, Steve, maybe you mentioned volatility and gross margin coming up, but I want to make sure I understand what the message was there.
And then maybe if you could also tie in the out of stocks. I thought that had abated last quarter.
I'm wondering if you can talk about what categories you're seeing that in and if we should expect that to moderate in the fourth quarter?
Steven L. Spinner
Okay, sure. Yes, I mean I just wanted to make sure that everybody didn't think that because we had a couple of quarters where our gross margin was stabilizing that we couldn't have some up or down volatility as we look forward.
We do think that the gross margin from here forward should be fairly stable. There's nothing that we know of today that would cause a significant decline like we've had in the last couple of years related solely to customer mix.
But I just wanted to caution folks into not thinking that it was going to be exactly the same quarter-to-quarter because it could go up or down, as I said. But there was nothing hidden in that message.
And then you asked a question on the supplier out of stocks. Yes, so what was, I forget, what was your question on supplier out of stocks again?
Kelly A. Bania - BofA Merrill Lynch, Research Division
I thought that the supplier out of stocks had kind of abated last quarter. And so I was just wondering if it was the same categories, and if you will think that it is kind of resolved at this point or as we think about the next couple of quarters?
Steven L. Spinner
Yes. So it's definitely getting better.
Sequentially, it was better than the second quarter, but it was still considerably worse than last year. So we'd probably have another 2 quarters where the comps are pretty tough.
But I think that we're going to start to see gradual improvement in the service level. We're still faced with some out-of-stocks related to some very specific products, and it's just going to take a while for those to get back up to the volume demand.
But like I said in the comments, we have a fair amount of confidence from the suppliers that they're on it, they're adding capacity, and we'll see it continue to improve.
Kelly A. Bania - BofA Merrill Lynch, Research Division
Great, that's helpful. And then if I can ask another one, just on the DCs.
I don't recall if those locations were announced, the, I think, you said Wisconsin, Hudson Valley and in California. And I was just curious if you can talk broadly about the process that you go through in determining those locations.
And I think you mentioned some of the independents maybe growing a little bit faster. Just curious how much visibility you have into that and if that plays into those decisions?
Steven L. Spinner
Yes. I mean, that's a good question.
I think a couple of years ago, we used to think that the most efficient way to build a distribution center was to build a mega center, 800,000, 900,000 square feet. You'd spread your fixed cost over a really wide berth, and that will be the most effective way to manage DC.
But what we learned was when you actually put the zip codes of your delivery points into a model, what we found was that whatever efficiencies we gained by building a big building, we actually lost in transportation cost. And so the analysis brought us to let's take a look at the geographies where we have the greatest saturation of customers and where we're driving the furthest distance to get to.
And that's where we need to build the facilities. And so when you look at a Racine, Wisconsin or sort of in Wisconsin, it's far more efficient for us to build a new building there and offset volume from several of our existing buildings that are at capacity than it is to build a singular mega center, far more cost-effective.
So our model moving forward will be to have what's called a foldout strategy, where we will build a building that's in somewhat close proximity, could be 200, 300 miles away from an existing facility. We'll offload volume from the existing facility into the new one, and it will just bring us closer to the customer and significantly reduce our transportation costs.
Mark E. Shamber
And then, Kelly, just to the other part of that question, our facility in the New York area is in the Hudson Valley area. It's actually in the town of Montgomery, and we have not yet signed on a location in Northern California, although we have narrowed it down to a couple of places.
Operator
[Operator Instructions] Our next question comes from Ajay Jain from Cantor Fitzgerald.
Ajay Jain - Cantor Fitzgerald & Co., Research Division
I guess just given that you have one quarter remaining this year, I wanted to clarify if the updated sales guidance is mainly related to the extra sales week because if I compare the midpoint of the original sales guidance to the new range, I think the incremental amount works out to the same 2.2% to 2.3% that you attributed to the extra week in your press release. So can you confirm if the 53rd week is mainly behind the new sales guidance?
And if it was just an issue that the calendar shift was not accounted for?
Mark E. Shamber
No. Actually, that's not the case.
I mean, the uptick was that we had strong -- we had much stronger -- we saw an uptick in the third quarter where we went from 12.3% in the second quarter, Ajay, to 12.8%, and we have seen that the first 4 weeks of the fourth quarter have seen a modest acceleration from there. So it's more a reflection of the continued sales growth and the improvement in the sales growth than it is anything to do with the 53rd week.
Steven L. Spinner
And the extra week was always in our guidance.
Mark E. Shamber
Right, the extra week, we had laid that out in the beginning. And we, I think even on the fourth quarter earnings call fiscal '12, we had kind of roughly estimated the number so that people knew that it was a 10 to 12 comp, roughly before the next 2-week was factored in.
Ajay Jain - Cantor Fitzgerald & Co., Research Division
Great, that's very helpful. And I just had one follow-up question.
I think, Steve, in your prepared comments, you gave out the sales contribution by channel, and maybe you gave it, but what was the growth of independents this most recent quarter for both independents and the conventional supermarket channel?
Mark E. Shamber
Actually, they are covered in mine. Steve only touched on the supernatural.
So the conventional supermarkets were 13.6% for the quarter and the independents were 8.3%.
Operator
Our last question is a follow-up from Andrew Wolf from BB&T Capital Markets.
Andrew P. Wolf - BB&T Capital Markets, Research Division
I have 2 follow-ups. The roughly $5.5 million of the noncash and I guess, now the cash moving costs at Aurora and Albert's, when we look and when you compare that to last year, was there any similar cost last year if we just want to adjust for that?
Mark E. Shamber
No. Well, I mean we -- the last time we had, had any cost of that nature, Andy, were in the first quarter and a little bit into the second quarter of fiscal '11 when we opened the Lancaster, Texas facility, but there were no such costs in fiscal '12.
Andrew P. Wolf - BB&T Capital Markets, Research Division
And you're saying going forward that we'll be, and depending how things fall out, could be awash or something like that?
Mark E. Shamber
Yes. I mean, it's right because we're going to have -- the new facility in Wisconsin will likely be done late in fiscal '14.
The new facility in New York will probably be some point in fiscal '15. I think it's a little bit early for us to comment on timing there because we haven't broken ground yet.
And then we have a new Northern California facility that will come on board some point after that. So as we look at the next couple of fiscal years, we'll likely have those types of expenses in that timeframe.
Andrew P. Wolf - BB&T Capital Markets, Research Division
And then just lastly, I think you mentioned inbound freight is a drag to the expense ratio. And either I missed it or maybe I didn't, but is that tied to your inbound freight system or routing or and I think last quarter you mentioned there was a lack of backhaul opportunities.
So could you just discuss what's the situation there and what -- when you see that might go through?
Steven L. Spinner
Yes. I mean, there's a few different things, but I think Steve, in his comments, touched on it in that, in instances where we have higher-than-normal supplier out-of-stocks and where we feel the need to address customer service-level needs.
We'll move products around at the higher expense on our side. And that is a component of inbound freight.
I mean, there may have been a few instances of some higher costs where we expedited shipment on directly coming in versus relocate -- versus moving it between existing DCs, but I think what we were trying to allude to there was more along the lines of we'll move things around, particularly when we continue to have service-level issues, we'll move things from DC-to-DC if we have the inventory in another location.
Andrew P. Wolf - BB&T Capital Markets, Research Division
Okay. So you're really, to some extent, you're dependent on the vendor community really getting back to kind of normal in-stock levels, if you want to properly service your own customers by extending that?
Unknown Executive
Yes, yes.
Operator
And I'll turn the call over to Mr. Spinner for closing comments.
Steven L. Spinner
Thank you for joining us this afternoon. Eat more organic and specialty food, and we look forward to presenting our 2013 fiscal year results and 2014 guidance this September.
I hope you all have a great summer. Thanks again for joining us.
Operator
Thank you. This does conclude today's teleconference.
You may disconnect your lines at this time. Thank you for your participation.